Alarms are going off about earnings quality 🚨

Let's talk about GAAP earnings, non-GAAP earnings, and operating cash flow 🧐

Portrait of Luca Pacioli, who is referred to as the father of accounting. (Source: Wikimedia Commons)

At TKer, we often say that earnings are the most important driver of stock prices in the long run.

Simply put, earnings (a.k.a. income or the bottom line) are what remain of sales (a.k.a. revenue or the top line) after you subtract all the costs and expenses (e.g., cost of goods, operating expenses, interest, and tax).

There are at least three ways to track a company’s earnings power: GAAP earnings, non-GAAP earnings (a.k.a adjusted earnings), and operating cash flows.

Generally speaking, these three metrics move roughly in line with each other over time. And when they diverge, people start to question the quality of earnings.

In recent months, these metrics have been diverging.